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Elevators' Marketing Jam

Corn prices at $6-plus and soybeans pushing $14 through 2010 are mighty tempting for growers looking to forward contract a year or two out. But in many areas, don't try it with your local elevator.

With the massive margin requirements grain handlers are now facing, about the only way to book prices past the current year's crop is through straight futures or options contracts. The margin calls are on your back.

Many grain handlers are limiting growers to cash forward contracting the 2008 crop only. Those contracts can go into 2009. There are also cases of marketing limited to 45-60 days out. Longer-term basis contracts and other contracts are available, but growers can still be held to futures price swings.

“Right now we're contracting only for 2008 corn and soybean production for sales into mid-2009,” says Doug Brown, director of operations, Ag Processing Inc., (AGP) in Omaha.

“Before, farmers would call the elevator, contract in a distant price, and we played the role of paying margin calls on the corn or beans. Many farmers didn't realize the value of that,” Brown says.

“Farmers can lock in some of their input cost for fertilizer and other items for 2009,” he says. “They should be able to lock in a crop price, as well.” Darrell Mark, University of Nebraska agricultural economist, says the enormous volatility of grain and other commodity markets has both elevators and farmers at a disadvantage when it comes to margining futures positions.

“Due to the frequency of the grain futures markets being bid limit-higher or limited-down for several days at a time, the daily futures-price limit on corn has been increased to 30¢/bu., up from 20¢, and soybeans were increased from 50¢/bu. to 70¢,” says Mark.

“When futures are locked limit-higher or -lower, it prevents traders from entering and exiting positions. These limits can be expanded to 150% in a trading session following a session when the price of two or more futures contracts traded to limit-higher or -lower,” Mark says.

That's part of why wild trading has caused some large and small grain elevators to disallow distant forward contracting because of the increase in margin-financing requirements. “Because grain producers, who also need to avoid the futures market for similar reasons, no longer have these cash contracting alternatives, they are left with significant risks that they cannot easily offset,” says Mark.

Margin requirements are the amount of money required to be posted as a performance bond in order to buy or sell a futures contract. They have been increased due to price volatility.

Last spring (March), the CME Group, parent company of the Chicago Board of Trade, instituted higher initial and maintenance margin requirements for both old- and new-crop speculators and hedgers for corn, soybeans and soybean oil.

The large volume of index-fund trading, estimated at two to three times the total crop production in some markets, drives prices up and the contracts can then be sold back for a higher price, notes Mark. This has generated concern over convergence between the cash and futures markets.

“CONVERGENCE OF THE futures market to cash prices ties futures prices to the supply and demand for the underlying commodity and occurs because of the possibility of delivery,” he says. “Convergence has occurred most of the time, but not as often as before.”

The Commodity Futures Trading Commission held a special meeting to discuss the convergence situation earlier this year.

Commercial hedgers are seeing lines of credit that are typically used to cover margin calls being depleted because their short futures positions generate large margin calls as prices increase.

“Not only does this result in a significant amount of money to finance due to larger margin requirements, but the cost of these funds likely is increasing as the hedgers' leverage increases,” says Mark. “This affects both small producers seeking to hedge in the futures market, as well as large commercial grain trading companies.

“Because of the increased costs of futures hedging, grain basis is weaker than historical averages, and grain buyers are not offering flat price contracts very far into the future,” he says.

Hillius says the crunch on elevators has taken the hedge-to-arrive (HTA) contract and other creative marketing programs virtually off the table for growers, who would likely consider using 2009 and 2010 HTAs to secure the high prices seen in corn and bean markets.

He says there is fear of what happened with HTAs in the mid-1990s, when elevators and growers were caught in situations in which HTAs for crops two and three years out were pummeled by deliveries that couldn't be covered and margin calls that couldn't be met.

“Lending institutions want elevators to be more careful in times like this,” says Hillius. “Bring up HTAs and they get a little edgy. We're basically just cash contracting for the 2008 crop out to the summer of 2009.”

Mike Franzluebbers, AGP grain merchandiser and marketing specialist, says that in late 2007, soybean prices traded in the 15-20¢ range daily. “Now they are easily in the 50-60¢ range,” he says. “With that much of a spread, you have to come up with more margin money more frequently.”

The situations faced by grain handlers means growers may have to take greater risks themselves to lock in distant corn and soybean prices. “We're seeing some growers use various put options strategies to lock in a price,” says Hillius.

“Growers may have to look at more options strategies,” adds Franzluebbers. “If you can't lock in your preferred price with an elevator or an end user, that may be the best strategy to take.”

Cattle, swine and feeders and dairy operations are also impacted by the high margin requirements on corn and soybeans. “Some end users of corn or soybeans can't buy anything past 60 days,” says Brown. “We're seeing some dairy customers buying only spot loads.”

Because of ethanol production and a large domestic and world demand for corn, soybeans and other grain, financial pressure on grain handlers and their abilities to handle margin requirements is expected to continue until alternative futures- and cash-contract management programs are established.

Hillius says that growers increasingly ask him what they should do. More than likely, grain handlers large and small are wondering the same thing.